Crunching the Numbers

In this section, you will begin by looking at the distribution of earnings volatility across the market. Specifically, you will consider what a high earnings volatility firm would look like and contrast it with a firm with stable earnings. The section is concluded by creating a portfolio of stocks that pass the “stable earnings” test.

Earnings Volatility Across the Market

As noted early in the chapter, there is no one accepted measure of earnings volatility. While you could construct statistical measures of volatility—standard deviation or variance in earnings—you would still have to standardize the numbers to make them comparable across firms. After consideration and rejection of a number of different approaches to standardization, the coefficient of variation in earnings, estimated by dividing the standard deviation in earnings between 1997 and 2001 by the absolute value of average earnings during that period, was used to measure earnings volatility.